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How Open Are Countries to Trade?

Monday, August 19, 2019

By B. Ravikumar, Senior Vice President and Deputy Director of Research, and Brian Reinbold, Research Associate

A common measure of trade openness is the imports-to-GDP ratio. This measure gives an idea of how much a country is exposed to international trade. The larger the ratio, the more the country is open. The list below reports the top 20 most open countries based on this measure. Feenstra, Robert C.; Inklaar, Robert; and Timmer, Marcel P. "The Next Generation of the Penn World Table," American Economic Review, October 2015, Vol. 105, Issue 10, pp. 3150-82.

Top 20 Trade Openness Measured by Imports-to-GDP Ratio (2014)

Barbados

Luxembourg

Estonia

Bahamas

Aruba

Netherlands

Slovakia

Lithuania

Fiji

Slovenia

Hungary

Czech Republic

Liberia

St. Vincent & the Grenadines

Switzerland

Belize

Austria

Iceland

Lesotho

Latvia

SOURCE: Penn World Table 9.0 See Feenstra et al.

We see that most of these countries are small economies. That makes sense based on this definition of trade openness: A smaller country cannot produce everything that it demands; therefore, it relies more on trade.

An Alternative Measure of Trade Openness

However, using the imports-to-GDP ratio to proxy trade openness does not incorporate a country’s potential gain if the world were to move closer to free trade. For example, a poor country and a rich country could have the same imports-to-GDP ratio (that is, the same trade openness) but very different potential gains from becoming more open to trade.

In a 2016 paper, Waugh and Ravikumar derived a trade openness index that quantifies the potential gains from trade. Waugh, Michael E.; and Ravikumar, B. “Measuring Openness to Trade,” Journal of Economic Dynamics and Control, November 2016, Vol. 72, pp. 29-41. Trade potential measures how much each country can gain by moving from a current world with trade barriers to a world with free trade.

Waugh and Ravikumar found that poor countries have more to gain relative to rich countries. This result implies that poorer countries are closer to autarky while rich countries are closer to free trade.By autarky, we mean a closed economy that is not open to trade. In other words, given a poor country and a rich country with the same imports-to-GDP ratio, measuring trade openness by the ratio concludes that the two countries are equally open to trade. However, the Waugh-Ravikumar trade openness index would find that the poor country is less open to trade because it has more to gain from free trade relative to the rich country.

Furthermore, this measure of trade openness is negatively correlated with trade barriers. This makes sense because a country with high trade barriers is far from free trade and is therefore less open.

The list above shows the top 20 most open countries based on the Waugh-Ravikumar trade openness index. This list is different from the one in the first table, where trade openness was measured by the imports-to-GDP ratio. The second table includes more developed, wealthier countries like Germany, the U.K. and South Korea. Again, a wealthier country likely has less to gain by moving closer to free trade. Therefore, it must already be closer to free trade.

By incorporating trade potential into a measure of trade openness, the Waugh-Ravikumar trade openness index more accurately captures trade openness than simply looking at the imports-to-GDP ratio.

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